Euro recovers from worries about France

Central bank holds steady on both U.S. rates and bond buys

By

DeborahLevine

WilliamL. Watts

NEW YORK (MarketWatch) — The U.S. dollar fell Thursday as the euro found its footing after a brutal rout the previous day, rebounding on hopes Italian lawmakers will move quickly to implement economic reforms and progress in Greece on forming a new government.

The shared currency also recovered after briefly paring gains on worries about France’s credit rating that were shown to be unfounded.

The euro
EURUSD, -0.7253%
rose to $1.3604 from $1.3553 in North American trade late Wednesday. The euro fell by as much as 2% Wednesday as Italian government bond yields spiked to levels widely seen as unsustainable and as a precursor to international aid.

Who is Mario Monti?

(3:56)

The former European Commissioner is in the frame for the top post in an Italian unity government. Hopes are that Italy will produce a surplus in the coming years and can service its debt.

The dollar index
DXY, +0.54%
, which measures the U.S. unit against a basket of six major currencies, fell to 77.660, from 77.885 on Wednesday.

Against the Japanese yen, the dollar
USDJPY, +1.01%
slipped to ¥77.67 yen, down from ¥77.87.

The euro came under pressure midmorning, which analysts attributed to worries about France’s rating.

It recovered after Standard & Poor’s later clarified that France would keep its AAA-rating. An automatic message sent out earlier due to a technical error suggested otherwise, the rating agency said.

The European and morning trading session were more focused on signs of progress in Italy and Greece.

Italy garnered decent demand at an auction of 1-year bills, though the cost to borrow surged from a sale of the same securities last month. Read more on Italy’s debt sale.

The yield on 10-year Italian government bonds (10YR_ITA) lately was 6.91%, a reversal after spiking to more than 7.4% on Wednesday. Yields move in the opposite direction of bond prices.

Strategists noted reports Italian lawmakers plan to approve economic legislation by Sunday. Also, President Giorgio Napolitano laid the groundwork for economist Mario Monti to lead an emergency government in Rome, The Wall Street Journal reported.

Separately, it was taken as a sign of progress that Greece named a new prime minister — Lucas Papademos, a former vice president of the European Central Bank — after several days of contention over who would replace George Papandreou. See more on Greece’s Papdemos.

“The main question is how quickly will we see additional action from European policy makers,” said Kathy Lien, director of currency research at GFT. “Even though the euro-dollar has rallied, doing nothing is not an option right now. The mild rebound in the euro is fueled partially by the premise that European officials are working frantically on a more aggressive response to the crisis.”

Europe on track to lose its currency?

(4:36)

France and Germany are discussing the possibility of splitting the euro, and Berlin may even be laying plans for countries to exit the euro. This marks a key psychological shift in thinking.

But strategists said any recovery by the euro may prove short-lived unless European authorities, including the European Central Bank, take steps to arrest Italian borrowing costs.

A large part of the fear with Italy being sucked into the region’s sovereign debt crisis is that it has much more debt than the other countries that have been given bailouts: Italy has the third-largest amount of debt in the world.

In its current form, the European Financial Stability Facility, the region’s bailout fund, isn’t big or strong enough to help Italy.

Some strategists said the European Central Bank already stepped in to buy Italian bonds, which is part of why the yields fell back so much.

To restore confidence in the very short term, “it will be absolutely necessary that Italy approves the recent fiscal measures and moves forward with either a coalition or technocratic government,” said Marc Chandler, global head of currency strategy at Brown Brothers Harriman.

“Yet a much more committed intervention strategy from the ECB may also be required as the EFSF is unlikely to be up and running anytime soon,” he added.

Bank of England stands pat

Also Thursday, the British pound found some relief after the Bank of England left interest rates and the size of its bond-buying program unchanged after its policy meeting.

The British pound
GBPUSD, -0.0079%
gave up gains to trade at $1.5924, compared to $1.5926 late Wednesday.

Sterling lost ground against the broadly-stronger euro
EURGBP, -0.6759%
which was up 0.5%.

Analysts still believe the Bank of England could move to further boost purchases as early as next month as it wrestles with a deteriorating economic outlook. Read about Bank of England decision.

“The escalation in the debt crisis in Europe vindicates the bank’s decision to act swiftly and pump the economy with money last month,” said Kathleen Brooks, research director at Forex.com.

But “the effects may not be clear in December, hence why it may wait until 2012 before acting again,” she said. Still, officials may further downgrade their inflation and growth forecasts, which would determine if they move to boost the quantitative-easing program in January or February next year.

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